A record number of people are entering retirement as the baby boomer generation approaches 65 years old. Between 2010 and 2030, the retiree population is expected to increase by 75 percent (from 40.2 million to 71.4 million).1 While this generation of retirees is healthier, more active and living longer than ever, many retirees are seriously unprepared economically for the financial requirements of retirement.
Over the past 20 years, we have seen a fundamental shift in how Americans prepare for retirement. In the past, the retirement income formula included three pillars: (1) Social Security, (2) employer provided and –defined benefit pension plans and (3) personal savings. Today, all three of these pillars are under stress. Our Social Security program is over-burdened and in desperate need of change to ensure its future health. Employers, once the guarantors of secure retirement for loyal employees, now have shifted retirement savings risk to individuals by replacing the previously defined benefit plan with newly defined contribution plans such as the 401(k). And responsible American savers have been hit with one of the worst investment decades since the Great Depression. To further complicate matters, many retirees of this generation are faced with costly maintenance and health care responsibilities for their own aging parents, who are also living longer.
Across all income levels, retirees are at risk of no longer being able to sustain their pre-retirement lifestyles. Based on the National Retirement Risk Index (NRRI), the majority of retirees surveyed face retirement risk. Five out of 10 high-income retirees are at risk of financial stress, while this number jumps to seven out of 10 for low-income households.2
Although these statistics sound bleak, the good news is that many options and viable solutions do exist to help people improve their chances of successfully achieving their retirement income goals and financial security. To help successfully navigate the retirement planning waters in this environment, one needs a comprehensive retirement plan that considers all available asset classes and resources, including among other possibilities, cash, fixed income, equities, guaranteed income and personal home equity. In fact, accessing home equity through a qualified reverse mortgage should be considered by retirees and financial planners in the overall retirement equation. Based on a 2010 Boston College study, when a reverse mortgage is considered in the equation, retirement risk may be reduced across all income segments.3
This is great news for Americans 62 years and older who collectively have more than $3 trillion of their wealth accumulated in the form of home equity.4 Home equity is too large an asset class for seniors and retirement planners to ignore when devising an individualized retirement strategy. When appropriate, there are two primary ways to unlock accumulated home equity in a personal residence: (1) sell the home or (2) borrow against the stored wealth. The first option, selling a home, may not be a preferred strategy for many seniors who often have deep emotional and physiological attachments to their homes and communities. In fact, 88 percent of seniors5 say they want to “age in place” and continue to live in their homes for as long as they can. A reverse mortgage can be a viable and affordable financial option for these retirees, who can gain access to additional cash flow while they continue to live and enjoy their home.
Over the years, I have come to know many financial planning professionals who do consider home equity as part of the retirement planning process when developing financial strategies with their clients, including clients of moderate to high incomes. These planners really understand the reverse mortgage product and its potential benefits and consider it a valuable alternative or supplement to other income sources in a sustainable retirement plan. However, a surprising number of financial and retirement advisors do not consider the potential benefits of a reverse mortgage and do not educate their clients on reverse mortgages because of basic misperceptions, confusion or general lack of product knowledge. So, what are financial advisors’ top misconceptions about using reverse mortgages?
1. A reverse mortgage should be introduced as a last resort.
I’ve had many conversations with financial planners who say they have clients who will get a reverse mortgage… in a few years. These advisors and their clients think about accessing home equity only after other assets are reduced. However, many of us in the reverse mortgage industry suggest that by waiting until such a late date to consider the use of a reverse mortgage, the planner may be missing some smart and creative planning opportunities that could help maximize the value of the client’s other retirement income resources, including Social Security benefits, retirement savings assets and pension plan distributions. In addition, home equity distributions may have advantageous tax consequences, which could result in numerous income tax planning benefits depending on the client’s individual situation. I will address a few of these potential planning opportunities later in the article. Further and perhaps more importantly, there is potential risk in waiting too long to consider the home equity option. Over time, the home equity cushion in a retiree’s home could decrease, as we have seen with recent depreciating home values.
Another risk is that the current government-sponsored and proprietary reverse mortgage programs may not always be available, and interest rates could begin increasing once again. Conversely, if better opportunities come along in the future, refinancing a reverse mortgage is an easy and affordable option.
2. It’s too expensive to do a reverse mortgage.
Too expensive compared to what? For this statement to make sense, we would need to compare a reverse mortgage to a similar alternative or substitute product. Yet I’m not aware of any other financial product that contains all the features, benefits, flexible payment options and consumer protections that the HECM reverse mortgage offers. This product was specifically designed to provide safe access to a percentage of a senior’s home equity by converting it into retirement income, with a government guarantee that the loan will be nonrecourse and that neither consumers nor their heirs will ever be personally liable for the debt regardless of whether the loan balance exceeds the home value when the loan becomes due and the home is sold. One of the most undervalued elements of the HECM program is the possibility for the consumer to request a line of credit or request equal periodic disbursements throughout the life of the loan. This is a very powerful feature, and one that provides flexibility and numerous financial planning opportunities. Many financial planners are unaware of the newest and lowest cost product in the HECM family, the HECM Saver, which nearly eliminates the initial closing costs and the initial mortgage insurance premium!
3. It’s better to sell and rent or downsize than to take out a reverse mortgage.
Not necessarily. Assuming that the client is not attached to his or her home, it’s nonetheless important to consider that selling and moving carries non trivial hard costs and opportunity costs. Selling and moving transaction costs can easily be $35,000 for a $500,000 sale assuming, 6 percent realtor commissions for the sale transaction and another 1 percent for moving expenses. As a renter, there is also a good chance that multiple moves will be required over time. If the senior elects to rent, he or she will have sold a valuable asset with the potential for appreciation in exchange for the inherent inflation risk associated with rental costs. If the client buys another home, there will be additional transaction costs incurred in the purchase, which takes another bite out of the home equity. After considering all the transaction and relocations costs, the net benefit to the consumer through a reverse mortgage could exceed the net benefits of other real estate transactions. With a reverse mortgage, homeowners (and heirs) retain any remaining home equity, after the loan is paid in full, at the time of sale. Moreover, the heirs have the option of either keeping the home or selling the home. Home retention and access to equity could also result in significant tax benefits to the homeowner. Interested seniors should consult with their tax advisors as the potential tax advantages exceed the scope of this article.
4. A home equity loan is better for my clients than a reverse mortgage.
Not necessarily. Traditional home equity loans and HELOCs typically require strict credit and income levels for approval by the lender, and they come with required monthly mortgage payments. Those monthly payments create a financial headwind if the client’s primary objective is to generate more cash flow. Furthermore, in the current economic environment, it is much more difficult for consumers to gain credit access to home equity loans, particularly for seniors facing reduced or limited incomes. In addition, most reverse mortgages have a nonrecourse clause, designed to prevent the client or his or her estate from owing more than the value of the home when the loan becomes due and the home is sold.6 There are no prepayment penalties with an FHA HECM reverse mortgage.
5. It’s legally challenging to offer reverse mortgages.
With the legislative and regulatory changes during the past few years, mortgage lenders and financial planners are more cautious than ever before in considering the cross-sale of financial services products and reverse mortgages, to ensure that reverse mortgage originators and financial planning professionals are not violating state and or federal laws.With properly designed safeguards and firewalls, reverse mortgage professionals can easily work with professional financial advisors to devise sound retirement and estate plans. It is important that both parties understand the state and federal laws and regulations, and that the lender is knowledgeable in this area and has established processes, procedures and compliance guardrails. Seniors, mortgage originators and advisors should avoid working with any financial planner who seeks compensation related to originating a reverse mortgage. With six out of 10 retirees dependent on financial advisors for retirement planning advice,7 it is critical as an industry that we effectively engage and educate planners on the potential benefits of reverse mortgage solutions for their clients.
For example, reverse mortgages may be used to help avoid retirement planning mistakes involving (1) inappropriate and inefficient utilization of Social Security benefits and (2) excessive distributions from retirement savings causing unnecessary and rapid draw-down. Using a Reverse Mortgage to Help Defer Ta king Social Security Today, record numbers of people are electing to take Social Security income distributions at age 62, which is the earliest age possible. Many financial planners suggest that healthy seniors delay as long as possible before starting their Social Security benefits, up to age 70. For example, a person who would receive Social Security benefits of $1,000/month at a full retirement age of 66 would get only $750/month if he or she claimed benefits at age 62. If instead, Social Security benefits were deferred until age 70, the same person would receive$1,320/month.8 This, however, is easier said than done. People are electing to receive their benefits early because they need the income to sustain their quality of life. That’s where a reverse mortgage can help. A senior can tap into home equity through a reverse mortgage to create an “income bridge” so that he or she may defer taking Social Security benefits until age 70. At age 70, the client can stop taking monthly distributions from a reverse mortgage and start taking Social Security benefits, which will then have nearly doubled for the rest of his or her life. Because any existing mortgage payments are also eliminated when taking out a reverse mortgage, there can be additional cash flow benefits for seniors.
Using a Reverse Mortgage to Stretch Retirement Savings Accounts
Many retirees have a very difficult time keeping their distributions from retirement savings accounts at a sufficiently low level to ensure their savings last throughout their lifetimes. Unexpected life events or health issues often come up, and low interest rates and poor equity market performance have resulted in low investment returns over the past several years.
One strategy for seniors and planners to consider is reducing the distribution from retirement savings each month and replacing it with a reverse mortgage home equity distribution from the HECM line of credit. By simply reducing the performance dependency of a single asset class, and adding a distribution from an additional asset class, the longevity of the retirement savings account can increase. This may help reduce the risk to the client of prematurely running out of money and depleting the retirement funds.
Avoid Reverse Dollar Cost Averaging
A reverse mortgage may also help seniors improve their overall portfolio returns over time. Many of us have heard about the benefits of dollar cost averaging while saving for retirement. The concept is based on a simple principle: If you invest a set amount in regular intervals throughout your working life, you’ll invest more of your funds at a lower average cost as the market moves up and down. In retirement, when taking systematic distributions from a retirement account, dollar cost averaging works in reverse, meaning you may withdraw more funds at lower values by selling more at lower prices. Assuming retirement savings are invested in the equity markets, one way to help avoid this phenomenon is to strategically use a reverse mortgage to take home equity distributions in lieu of retirement distributions during years following very low or negative returns in the equity markets. This gives your retirement savings a chance to rebound in future years when equity market gains return.
Reverse mortgage originators are well positioned to work in local communities and partner with financial planners to provide education on the benefits of a reverse mortgage. Remember that as a reverse mortgage origination professional, you are the expert on these products, and financial planners will need your assistance in determining whether a reverse mortgage fits into an individualized client financial objective or retirement plan. We are seeing more and more clients being referred by financial planning professionals, and this trend will likely continue as more baby boomers enter their retirement years. Please remember to seek detailed advice from a tax professional or accountant as necessary.
Keep in mind that you want to work with reputable, fee-based financial planners and work with a reverse mortgage lender who has well-designed policies, procedures and the regulatory guardrails to help protect the client, the professional financial advisor and the reverse mortgage originator.
1. Retirement Population Statistics: US Census Bureau, US Interim Projections, March 2004 Table A.
2. NRRI Fact Sheet No1, March 2010. Center for Retirement Research at Boston College.
3. Home Equity Statistics: National Reverse Mortgage Lenders Association (NMLRA/Risk Span RMMI Q1, 2011).
4. Statistics on Aging in Place: AARP Home and Community Preference Survey, November, 2010.
5. Federal Trade Commission. Reverse Mortgages: Get the Facts Before Cashing in on Your Home’s Equity.
6. INFRE, Society of Actuaries, LIMRA Report. 2011. The Financial Recovery for Retirees Continues.
7. SSA Publication No. 05-10147, ICN 480136, July 2008.